INR: The Curious Case of RBI’s Supposed Hands-off

The recent INR strength has taken markets off guard, with INR gaining more than 1.6% in just last five trading session, having even seen the intra-day lows of sub-73/$. The intrinsic near-term appreciation bias on INR is not too surprising given:

(1) Healthy non-portfolio flows - Adani green dollar bond-led flows , AT1 bond issuances of a certain bank, FDI flows in general,

(2) FII turning net buyers in Aug again for equities (+$628mn) and FPI debt sees first positive print in the year ($1.6bn - highest since Mar'19) ,

(3) Generic DXY weakness post Jackson hole, spilling on to EMFX.

We note Indian equities have also had a solid run in Aug, rising a substantial 11% (USD terms) and outperformed broader EM markets in Aug - MSCI APxJ/EM (+1.9%/+2.4%). The cross country FPI flows also show a better FPI allocation in India.

The surprise however was on account of RBI's hands off strategy, letting INR to be on stronger (and volatile) footing, outdoing gains seen in most Asian FX amid DXY weakness.

This is in contrast to July when most of Asian FX corrected on dollar strength. We note INR is the best performing EMFX in Asia 3QCY21 so far, having returned 1.8%.

A part of RBI's this hands-off FX strategy seen in fag end of Aug could be attributed to:

(1) not letting the domestic liquidity conundrum convolute further, especially when they were lurching at huge forward maturity by Aug-end of ~$7.5bn,

(2) possibly making some trading profits off the INR moves since July for its own books,

(3) some temporary pressure off imported inflation.

However, assuming this RBI FX strategy to be a sustained one is too early to conclude.

INR upward pressure may continue amid possible portfolio (IPO line ups ahead, VRR debt limit exhausted but not utilised yet, Taper led global worry fading) and non-portfolio foreign flows (ECB debt, FDI) and we think RBI will mostly engage in two-way FX intervention with an active bias towards keeping INR somewhere in the middle of the EM pack.

Needless to say, intertwined policy objectives would mean RBI's FX strategy will also come with some cost.

The author, Madhavi Arora is Lead Economist, Emkay Global Financial Services.